By Guy Rigby, Head of Entrepreneurs at Smith & Williamson

The following article is an edited extract from Guy Rigby’s book, From Vision to Exit — The Entrepreneur’s Guide to Building and Selling a Business.

Some businesses that are focused on a long-term value creation strategy will happily endure losses in the early stages. These will typically be VC-backed businesses, where success or failure is ultimately determined by the quality of the proposition, the intellectual property rights (IPR) and the expertise and ability of the management team.

As Julie Meyer, online Dragon and co-founder of First Tuesday, observes: “When you’re building something which doesn’t exist and bringing something brand new to market there’s an investment and a cost of customer acquisition. So, while profit is hugely important, a lot of early stage companies have a J-Curve (initial losses followed by an uplift in performance, like the curvature of a ‘J’). Why is that? Because they’re investing in and betting on their insight.”

Such companies and their investors have a patient attitude to profit, coupled with an unshakeable belief in their strategy and business model. They are certain they will profit in the future and they are prepared to risk financing their growth by using their own or external capital.

Take Moonpig.com, the online greeting card service. Founder Nick Jenkins adopted an incredibly patient attitude to growth which has reaped remarkable rewards. Having launched the website in 1999, it took six years to reach break- even. The business lost£2.5m before it made any money. But a little over a decade later, in 2010, turnover reached £31m with a pre-tax profit of £11.2m, with the company owning the vast majority of the UK’s online card market. At the end of year one, revenues were a mere £90k while overheads reached £1m. The story shows that short-term losses can often be par for the course if your long-term strategy is to build a market-leading enterprise.

The good news is that Moonpig’s cash flow is no longer a problem. No cards are printed until they’ve been paid for by the consumer, whilst stock “accounts for less than half a per cent of turnover” says Nick. The result is a cash rich business — one which has benefited from a long-term strategy that didn’t focus on short-term profitability.

Nick recognised that his business was growing organically and would eventually succeed. As early as 2002 he could see that if the business carried on growing at the rate it had been, it would break-even purely on organic growth. It was just a question of waiting and funding the losses until that happened.

“What’s important is that I understood that it was going to work, because I spent a lot of my time measuring the data and working out what the lifetime value of the customer was,” explains Nick. “I was able to model it forward. That understanding gave me the confidence to realise that we were going to break even.”

Once the company had started to make a profit in 2005 it was able to begin to reinvest its profits in growth. Part of that reinvestment of the profits was wisely spent on its catchy and highly successful TV advertising.

Along the way, Nick didn’t just focus on data and customer analysis. He also devoted a lot of time to fine tuning the technological infrastructure. He needed to create a ‘complex automated system’ that would record each stage that every card goes through, a system which has taken ten years to refine.

Plus, there’s ample opportunity to continue growing, with the entire UK greetings card industry estimated to be worth approximately £1.5bn. Moonpig is a huge entrepreneurial success story. It shows that, whilst profitability is extremely important, it can be elusive in the formative years of a business. In addition, it seems that too much focus on profit in this kind of early-stage business might cause lasting damage and act as a barrier to future success.

What’s the lesson? It can take both time and money to build a great business, so make sure you’ve got enough of both!

For further information, contact Guy Rigby on 020 7131 8213 or by email at guy.rigby@smith.williamson.co.uk

To buy your copy of ‘From Vision to Exit — The Entrepreneur’s Guide to Building and Selling a Business', click here.

By necessity this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Article correct at time of writing.

Smith & Williamson LLP
Regulated by the Institute of Chartered Accountants in England and Wales for a range of investment business activities. A member of Nexia International.